Homeowners Face Costly Choice To Avoid Tax On Gain

Tax Answers

February 12, 1990

Q: My wife and I were married in June 1988 after both being homeowners. We immediately placed her home for sale and closed in January 1989 for a sale price of $65,000. She had purchased the home in 1981 for $41,000. After fees and expenses, approximately $20,000 in gain was realized. We now live in the home I purchased in 1984 for $90,000. Only my name is currently listed as the owner.

My questions:

* How can I minimize the capital gains taxes on the $20,000?

* Does the sale satisfy the requirement of "main home" on Form 2119?

* Could I refinance our "new" home and place both names as owners and satisfy the "Applying Separate Gain to Basis of New Home" on Form 2119?

W.B.,

Hayes

A: There is one sure, but expensive way to avoid paying tax on the $20,000 gain. If you were to buy (each of you providing half the purchase price) a new residence equal or greater in price to the adjusted sales price of both previously owned houses, you could postpone the gain on both. Adjusted sales price is the selling price less expenses of sale and fixing-up expenses (subject to time limitations). This would have to be accomplished within two years from the date your wife sold her house.

The reference to "Applying Separate Gain" on Form 2119 doesn't quite fit your circumstances, but could in the future. If you both continue to live in your current home for now, but purchase a jointly owned home several years from now, this would apply. At that point you can elect to share the postponed gain on the old house and subsequent bases reduction to the new house. For example, assume you sell your old house for $100,000 and bought a new jointly owned house for $100,000. On the surface it appears you have bought a house of equal value and can postpone the $10,000 ($100,000 sale price less $90,000 basis) gain. However, without the joint election, you would be deemed to have bought a $50,000 share in the new house and would have to pay taxes on the gain.

Refinancing your home will not qualify as a new residence. The IRS does specify that only purchase or construction of a new residence allows postponement of gain.

The IRS use of "main home" usually refers to the home you are in the most often. In postponing gain on the sale of personal residence, the term is used specifically to keep you from using this treatment on a vacation or second home.

Q: I retired as a Virginia state employee with 100 percent disability as of Jan. 1, 1989. My income during the year was:

* IRA distribution.

* Unused annual leave payment.

* Wife's income.

* Social Security disability payments.

* State disability payments.

I am certain that items 1, 2 and 3 are taxable. However, I am not for certain if item 4 and 5 are. My monthly Social Security payments do not show that tax is being withheld. My state checks have federal tax withheld.

Are item 4 and 5 reported on the federal and state tax return, or do they have to be?

I understand there is the question of $32,000 coming into consideration when Social Security is involved. I don't quite understand this either. I have two friends who are also retired for disability and their adjusted gross income exceeds $50,000 per year. H&R Block prepares their returns and for some reason the Social Security is not being reported on the federal or state return.

I have called the IRS and State Taxation people asking this question. I received four different answers from the IRS and no answer from the state.

A.R.,

Hampton

A: Your Social Security benefits are potentially taxable up to a maximum of one-half the gross amount. The $32,000 is the case amount for use in calculating the taxable portion for a married couple filing a joint return. After adding all of your taxable income, plus tax-exempt interest, plus one-half of the Social Security, subtract any adjustments to income (Form 1040, line 30) and the $32,000 base. If you still have a positive income amount, divide that number by two. Compare this to one-half of the Social Security and the smaller of the two will be taxable. By now, you should have received a Form SSA-1099 that will provide you with a worksheet to help with this calculation. The state of Virginia does not tax Social Security benefits. You can subtract any amounts included in your federal AGI on the state Form 760, line 35.

There is a credit for the elderly or disabled available that is based on age, disability, and nontaxable pensions. From your questions, it appears that your income is too high to allow use of the credit. For example, assume you and your wife are both under sixty-five and only you have retired on disability. If you received more than $5,000 in non-taxable Social Security or your joint AGI is more than $20,000, you would get no benefit from the credit.

Incidentally, a married couple who lived together at any time during 1989 will not avoid the limitations by filing separate returns. If you file separately, the maximum Social Securty is automatically taxed and the credit is disallowed.